Something is stirring in the currency jungle, and those who know its terrain best wonder whether it is the mighty beast — the dollar.
After weeks of lying low after a sustained period of weakness, rumblings of its familiar growl are starting to be heard, distant though the sound may be. The index that measures the dollar against a basket of its major peers picked up last week, while 10-year Treasury yields are also rising.
“There is a case to be made that the dollar has hit a bottom, at least against the euro and the yen,” says Steven Englander, FX strategist at Citigroup.
The dollar index fell more than 5 per cent in the first 15 weeks of the year. Since then, it has retrieved about a quarter of that loss, although it was back on the defensive yesterday.
What happens next to the reserve currency depends on the Federal Open Market Committee meeting today. In all likelihood, Fed chair Janet Yellen will once again fire off at the dollar another of those tranquilliser darts that have tamed its strength since early February, repeating the cautious tone about US growth and inflation she presented during last month’s speech to the Economic Club of New York.
The question across the FX landscape is whether the dovish tranquilliser is losing its potency. Growth may look weak, but Bank of America Merrill Lynch is among those that detect rising inflationary and wages trends and continued jobs growth.
Adding to the mix are more temperate conditions for growth in emerging markets, stronger equities, better news from China and a sustained rally in oil. The case for another rate rise in June is firming up, and the message to investors is that those with a whiff of risk in their nostrils should consider buying the dollar for a longer term horizon.
Three reasons stand out for investors to be more upbeat about the dollar, says Jane Foley, strategist at Rabobank. Risk appetite is on the rise, FOMC members are making more noises about the prospects of a June rate increase and long dollar positions have been pared back for more than a year.
The Fed is the only major central bank likely to raise rates this year while further easing from its peers “should lend the dollar support”, says Ms Foley.
What holds investors back is the sense that Ms Yellen will remain careful not to fan renewed market turmoil.
“Given the amount of uncertainty out there, [central banks] have managed to create some sense of stability,” says Charles St-Arnaud, FX strategist at Nomura. That stability dates from the G20 meeting in Shanghai in February, which some commentators believe established a truce among central banks to refrain from excessively weakening their currencies.
“If you are a business, you want relatively stable exchange rates to make your plans,” says Mr St-Arnaud. Ms Yellen’s dilemma is that if conditions do merit a shift in the Fed’s outlook, how does she do so without upsetting the market?
Several commentators believe it is the dollar’s weakness that it is firing the oil rally and in turn boosting commodity and EM currencies. So it stands to reason that a dollar revival would force down commodity prices and revive worries about China’s currency.
Kit Juckes, strategist at Société Générale warns: “The Fed has painted itself into a corner. The odds of a June hike are now down at 20 per cent and the FOMC can’t signal a move without triggering market turmoil.”
Policymakers expect two interest rate increases in 2016, while the bond market prices in none. “What if the Fed delivers what it says it is going to deliver?” asks Mr Englander. “Is everything going to fall apart, or is the market going to be more resilient to surprises?”
He warns that the market should therefore anticipate the Fed disappointing dollar bull investors, and for that reason, “EM and currencies will have a good week”.
At some point something may give, though for now a dollar that has catnapped its way through 2016 may continue to sit things out. The jungle should beware, however — the dollar is perking up and getting ready for a sustained run.